Lecture 23 - Perfect Competition

characteristics of a perfectly competitive market
demand curve facing a perfect competitor
what does the MR curve look like for a perfect competitor?
profit maximization
the shutdown decision
firm's short-run supply curve
zero long run profits

Charcteristics of a Perfectly Competitive Market

many buyers and sellers

identical product

free entry and exit

perfect information

Demand Curve Facing a Perfect Competitor

The market price in a perfectly competitive market is determined by the
market supply and demand curves. An individual firm in that market
cannot
charge more than the market price and will not charge less. So, the
demand curve facing an individual firm is horizontal at the market
price,
that is, it is perfectly elastic.

What Does the MR Curve look like for a Perfect Competitor?

A firm maximizes profits by producing where MR=MC. For a perfectly
competitive firm, the marginal revenue curve is the same as the demand
curve.

Q P TR MR
0 $1 $0
1 1 1 $1
2 1 2 1
3 1 3 1
4 1 4 1

Profit Maximization

A perfectly competitive firm can generate profits or losses in the
short run.

The Shutdown Decision

In the short-run, certain costs, such as rent on land and equipment, must
be paid whether or not any output is produced. These are the firm's fixed
costs. When the firm is deciding whether or not to produce any output at
all (the level of output is given by MR=MC), the firm looks only at its
variable costs. The firm will produce if it can earn sufficient revenue to
pay the variable costs.

produce if TR &gt TVC (if P &gt AVC)

shutdown if TR &lt TVC (if P &lt AVC)

Firm's Short-Run Supply Curve

The short-run supply curve of a perfectly competitive firm is the
portion of its Marginal Cost curve above the Average Variable Cost curve.

Zero Long Run Profits

In the long-run, firms can enter and exit the industry. Economic
profits will encourage firms to enter the industry. The increase in the
number of sellers will increase supply and cause the market price to fall
until the profits disappear. Firms will leave the industry when economic
losses are being incurred. The decrease in the number of sellers
decreases supply and causes the price to rise until the losses vanish.
In the long run, firms in a perfectly competitive
market earn zero economic profit. Also, in the long run, the
price in a perfectly competitive market will equal the minimum of
long-run average costs. Firms will be producing the good at the least
cost. Therefore, perfect competition results in economic efficiency.

David A. Latzko
Business and Economics Division
Pennsylvania State University, York Campus
office: 13 Main Classroom Building
phone: (717) 771-4115
fax: (717) 771-4062DXL31@psu.eduwww.yk.psu.edu/~dxl31